Why Deutsche Bank Isn't Another Lehman

September 21, 2016

Marco Mazzocco, The Street

Deutsche Bank (DB) has been in the news recently as being the next possible Lehman Brothers or AIG (AIG) that will bring down financial markets in a scenario like that of the financial crisis. While the current DB situation has brought back fears from the depths of the financial crisis, it has also demonstrated how the regulations that were put in place since the crisis do indeed work and have significantly reduced systemic risk.

Going back to the fall of 2008 when Lehman went bankrupt and AIG had to be bailed out, the major risk from these situations was called "counterparty risk" (CP). CP risk refers to the possibility that a participant in a trade will not be able to cover their obligations. The failure of a CP in a trade leaves the other participants with not only a worthless trade, but also a much more serious situation of having positions that are now unhedged if they were relying on that now-failed CP.

Until the financial crisis, the derivatives market was designed in a way that all trades were executed and then remained as contracts between the executing parties for the life of the trade, thus creating significant CP risk. The Lehman bankruptcy was manageable because Wall Street was able to take all the trades in which Lehman was a CP and essentially replace Lehman with another bank in order to keep the trades alive. Basically, the Street shared in the pain of the reallocation of all Lehman's trades. Read more